An Empirical Study On Contrarian Strategies In Chinese Stock Market

The traditional efficient market hypothesis (EMH) holds that stock returns are unpredictable and investors can only get the normal return. However, in recent20years, empirical research and theory of behavioral finance both found some "anomalies" which do not conform to the traditional efficient market hypothesis. According with these "anomalies", if we take appropriate investment strategy, we can earn higher return than the market. One of the "anomalies" is the contrarian phenomenon, namely stocks or stock portfolios that experienced poor performance in the past will be reversed in the future. The contrarian strategy, which is to buy past losers and sell past winners, will bring investors excess return.There are two kind of explanations to understand the contrarian phenomenon, the first kind is risk compensation hypothesis which derived from the efficient market hypothesis, the risk compensation hypothesis holds that contrarian strategy will bring investors more systematical risk, and the excess returns is the compensation for the risk. Another explanation comes from the overreaction hypothesis of behavioral finance, the overreaction hypothesis connects the reversal phenomenon with the decision of investor psychology and behavior. The overreaction hypothesis holds that the excess return comes from investors’ overreaction. Specifically, the investors extrapolated the past earnings growth rate into the future, or investors placed very high expectations on growth rate for the glamour stock, ignoring the "regression" rules. So after a certain time, price of glamour stocks will decline, and price of the value stocks will rise, holding the value portfolio will obtain excess return than the glamour portfolio.As we turn to the Chinese capital market, since the Shanghai and Shenzhen stock exchanges established successively in1990,23years have been passed. During this period, China’s capital market has experienced rapid development, the number of listing Corporation, the number of A shares and the proportion of the market capitalization to GDP are all constantly rising, the market index changed radically; institutional investors experienced rapid development since2000, by the end of2011, the proportion of market capitalization which institutional investors hold to the whole market was more than50%, which significantly changed the structure of investors market.The domestic academic circles also found inversion phenomenon through empirical study. But most of these studies were based on stock market data before2005, while equity division reform in2005had took far-reaching impact on Chinese stock market, and as the main force of value investment, the proportion of market capitalization which institutional investors hold to the whole market was only7%,so it is necessary to test the contrarian phenomenon from a relatively long period. But more importantly, in the interpretation of the contrarian strategy, domestic research had got controversial conclusion consistently. Based on more than20years data of the Chinese stock market, this article tries to check whether the contrarian phenomenon exists, and tried to explain the contrarian phenomenon.First of all, this article constructs portfolios and finds that the value portfolio will yield higher return than the glamour portfolio in the holding period, and the excess return grows with the holding time, even after adjusting the size of different portfolios, value portfolio will still earn higher return. In short, the contrarian strategy also applies in China.Second, this study tests if Chinese investors can be characterized by optimistic extrapolation. According to compare the value multiplier and the actual growth rate in the future for both value and glamour portfolios, we found that investors do make higher expectations of growth rate on glamour portfolios, and make too low expectations of growth rate on value portfolios. But it turned out that, the expected future growth rate is not consistent with the actual performance. In fact, the gap of the actual growth rate in the future between value and glamour portfolios will gradually reduced. By comparing past and future growth rate between value and glamour portfolios, the article found that, despite the glamour portfolios experienced high growth and the growth rate of the value portfolio was very low, but its past high growth rate of glamour portfolios did not continue into the future. In addition, even if the glamour portfolios past growth rate continue,1Yuan investment on the glamour stock will need a very long time to reach the same value with the cash flow or the sales income of value stock. Regardless of retail investors or institutional investors, this length of holding period is unlikely to achieve.Finally, the paper tests if the excess return of the contrarian strategy is from higher systematic risk. Firstly, we present the excess return of value portfolio in all years, for those which value portfolio return was lower than the glamour portfolio, we compare the lower return with the index return rate, to observe if the while value portfolio return is lower the index is also declining. Secondly, the paper divided the whole market into four cases:the worst, the best, the next worst and the next best markets, based on Shanghai synthesis index returns and GDP growth rate respectively.Then we observe the return of value portfolio and glamour portfolio in the four different market cases, it turned out to be that, however the market was divided, value portfolio yields are lower than glamour portfolio in the worst market. As a supplement to test the risk-premium hypothesis, we observed the traditional risk factors, such as beta and return standard deviation of different portfolios, and found that traditional risk factors of the value portfolio are all higher than glamour portfolio, which verified that the contrarian strategy assumed greater downside risk.